Russia’s regional projects: the uneasy dilemma underlying Russia’s scramble to accelerate development

Russia’s regional projects: the uneasy dilemma underlying Russia’s scramble to accelerate development
The coronavirus epidemic has exposed the chronic underinvestment into Russia's regions. The government and development agencies have been shaken up and a regional development plan developed that is connected to the 12 national projects, but will it make a difference? / wiki
By Andras Toth-Czifra in New York December 7, 2020

When the tech-savvy Mikhail Mishustin was appointed prime minister in January after years spent improving the efficiency of federal-level tax collection, it seemed obvious that his main task is going to be breathing life into the 12 national projects, a set of twelve ambitious development goals set in 2018 by Vladimir Putin for his fourth presidential terms.

The implementation of the national projects was lagging behind and it seemed almost symbolic that a competent new handler should be appointed on the same day as Putin announced his other big political project for his fourth presidential term: the reform of the constitution.

But then came the COVID-19 pandemic and upset all plans, or so it seemed: the government, which counted on a favorable fiscal situation, suddenly had a crisis to handle and the deadlines of the national projects were pushed back from 2024 to 2030. It seemed that – similarly to previous grand development schemes – this one would also fall victim to an unexpected crisis.

In November, however, despite a still-raging pandemic, Mishustin seemingly picked up where he left off in April and announced a sweeping reorganization of Russia’s development institutions, complete with a government reshuffle, which, among other things, seemed to strengthen his team. At the same time, the federal government’s plans with regions remain unclear.

Government shake up

Most regions are badly in need of substantial investment but due to budgetary constraints and political centralization they had been a bottleneck for the national projects even before the pandemic. As long as political and development goals are not aligned, this will hardly change.

On the surface, Mishustin’s reshuffle ticks all the boxes. It is true that Russia’s so-called development institutions – a loose term that can mean anything from specialized budgetary funds to state-owned monopolies – have been a financial sinkhole, so consolidating them is a welcome step.

The government also plans to reduce the number of public servants (which usually means the sleight of hand of closing vacancies rather than dismissing people) and there are talks of the obligatory hi-tech element too: an artificial intelligence may not become Russia’s president just yet due to its lack of “a heart, a soul, a sense of compassion or conscience”, but apparently this might not be an obstacle for an AI to evaluate the performance of regional governments.

The reform also aims to make the remaining institutions more transparent, which, again, would be a positive development, given that in the past these funds and companies were often used to hide inefficient spending or build a patronage network.

The reshuffle also asserts Mishustin’s authority in the government, which may thus be re-established on a firmer footing in the process of decision-making and implementation. Beyond these immediate gains, however, the question remains whether the reshuffle will make spending on development more effective.

Purses and strings

Half (51.3%) of the planned spending on the national projects is federal money. A fifth (19%) should come from regional budgets and the rest from so-called extra-budgetary sources. Thus, even assuming that budgetary funds are all spent, which has not been the case, the projects rely on heavily on something called the fiscal multiplier – a number expressing how much economic growth each percentage of increase in federal spending generates – which is very low in Russia. This is partly because the investment climate in most of the country remains hostile or at least difficult.

Russia’s investment rate in 2019 was a mere 20.6% of its GDP. In effect, investment is heavily concentrated in Moscow and the Moscow Region (in 2019 it was 21%) and in oil and gas producing regions (typically in a small number of large projects).

The federal government could then use the national projects to direct investments into other regions, but in reality, this is rarely followed by an organic growth of investment.

Regional governments and economic elites could also fill the gap, but due to a significant fiscal and political centralization that took place in the past two decades, most of them – especially oil and gas-producing regions – have transferred a growing chunk of their revenues to Moscow and most of them rely on federal redistribution in the form of grants and subsidies, a lot of, which come with strings attached.

Regional budgets rely on own revenues too, including 17% percentage points of the 20% they charge in corporate income taxes, but large companies are often headquartered in Moscow or St. Petersburg and are also taxed in these cities – a frequent source of frustration for the regions. Regional governments, on average, spend 70-80% of their budgets on health care, education and social transfers, and have barely any room to support development beyond road and housing construction.

Some do it anyway. Regional development institutions, of, which there are roughly 200 in Russia’s 83 regions (plus the occupied Crimea) more or less fulfil the same role as federal development institutions (officially at least), only on a much smaller scale. They take the form of regional budgetary funds to support entrepreneurship or technological innovation, but they can also be business incubators – for instance, industrial parks – that support small and medium enterprises. What is common in regional development institutions is that they tend not to be too successful. A 2015 study by the Russian Academy of Sciences found, for instance, that the only really successful institution was the industrial park of the Kaluga Region, but this was mostly due to the infrastructural development of the region (and likely business-friendly policies), not necessarily the park itself.

The deadlines of the national projects may have been pushed back to 2030 due to the pandemic, but the so-called key performance indicators (KPIs), a set of highly quantitative measurements that the federal centre uses to evaluate the performance of regional governors, were not abolished or suspended; governors are still incentivized to prioritize spending on the projects. Regional budgets, however, suffered. Their total loss of revenue in the first eight months of the year was more than RUB500bn ($6.7bn) and unlike the federal budget most of them cannot rely on budgetary reserves, either. Regions across the board benefited from increasing revenues in 2018 but the reserves accumulated from these have been exhausted, while their financial obligations only grew.

Most of the loss was due to a drastic reduction of corporate income tax revenue (by almost one-fifth). At the same time, regions had to spend significantly more on health care (a 67% spike or 85% with Moscow included) and supporting their local economies. The deficit was plugged by the federal government, but in an untransparent manner where some regions were overcompensated for their losses and some received only a fraction of the losses incurred, with no apparent logic behind the spending, that puzzled even Natalya Zubarevich, an eminent expert on regional economies.

Most of the additional funds were targeted, which means that regional governments face constraints on what they can spend the money on. Regions that became unable to execute their spending obligations – or, as media imprecisely reported, went bankrupt – such as Ingushetia, are taken under the direct financial stewardship of the Ministry of Finance, de facto eliminating the last vestiges of their fiscal autonomy.

Political taboos

Regions face further losses in the coming months as the economic burden of the second wave weighs down on them. At the end of October the Centre for Strategic Development warned that 19% of Russian companies would face problems paying taxes in the near future, especially small and medium-sized enterprises (SMEs).

SMEs play an important role in maintaining the health of regional economies but even before the pandemic, their activity had been stagnating or falling. There is a considerable risk that the pandemic, which weighs down especially hard on services, will accelerate this process. Yet the federal government, as Putin’s spokesman Dmitry Peskov indicated recently, does not plan to adopt a further stimulus package for business. And while in the third quarter payments to the population meant that in 61 regions people’s income actually rose, on average, the effect of this will peter out with no additional help in sight.

This will then translate into a smaller tax receipt, which means that the federal government will ultimately have to foot the bill anyway – only the autonomy of several regions will be weakened in the process.

As a bare minimum, a steep growth in regional debt seems unavoidable even if the Finance Ministry continues issuing cheap budgetary loans – a policy that it started in 2016 to replace market loans that threatened to throw regions into a debt crisis – and this is far from certain.

While the government will dole out RUB80bn from its own reserve fund to the 39 hardest-hit regions so that they are able to meet their fiscal responsibilities, this is little more than a fiscal sticking plaster and will be targeted aid. Due to complaints from regional authorities, the Ministry of Finance seems to have recognized that it needs to loosen the strings attached to federal transfers if regions are to exit the pandemic-related economic crisis. One suggestion was that regions could redirect additional funds from the national projects, but some governors – such as Chelyabinsk’s Alexey Teksler – indicated that this is not going to be enough. Due to the uncertainty of federal transfers, Teksler’s region struggles with budgetary planning, which in turn has prevented municipalities that rely on transfers from the region, from adopting their budgets. This may complicate or halt works like snow removal or renovations – in other words, the kind of jobs that have a direct impact on the mood of city-dwellers.

The underlying logic of fiscal and political centralization, meanwhile, is unlikely to change. A series of laws (including parts of the constitutional reform) and interviews by members of the security elite this year has suggested that the federal government is worried about initiatives to strengthen regional autonomies. This may partly be a consequence of their memories from the late 1990s when the Federation falling apart was considered a realistic possibility and several regions took their own initiatives, defying Moscow, in the wake of the 1998 financial meltdown. Growing regional unrest in the past two years – triggered in part, ironically, by an increasing centralization of resources in the capital – probably didn’t help either.

Further bills in the legislative pipeline point in the direction of the Kremlin holding the reins. An upcoming law on so-called federal territories, which will allow the federal government to directly administer certain regions, is probably going to erode regional fiscal autonomy even more and will likely create opportunities for big state-owned or state-linked firms to encroach on regions, something that we already see in the field of waste collection (e.g. Igor Chaika’s Khartiya) or digital technology and surveillance (Rostec).

In short, while Mishustin’s reshuffle may make some difference, even a welcome move towards bigger transparency and eliminating inefficient structures, it will hardly be enough to bring about the investment boost envisaged by the national projects. With all his political ambition and credentials of an efficient administrator, Mishustin is able to do enough with the political inertia of the system that points towards more centralization and less room for independent regional initiatives. Moscow’s priority is political stability, not progress.

But is one possible without the other? It is questionable whether this rigid approach will allow the federal government, regions, or even the revamped development institutions to address problems like health care capacity – the pandemic exposed chronic underinvestment, including in Moscow – a growing debt burden on private citizens or regional animosity towards Moscow. The crisis of Russia’s multi-level governance has been lurking behind the scenes in the past decade. The national projects, the pandemic and the return of regional politics allowed it to take centre stage. The central question of the next years is going to be whether the Kremlin is willing to give up some control in exchange for a less risky model of governance and development, or it chooses to go the other way.